Why I'm Shorting Commercial Real Estate

It has been feast or famine for us in commercial real estate the past 10 weeks; we made some fantastic gains in February and took some egregious losses in late March and early April. Much of the chatter on the internet is HAL9000s across America (quant funds) took some massive hits in a very crowded (short) trade. This is an incredibly troubled sector, but when too many people are at the party, the fundamentals don't matter for a while and some epic squeezes can happen.

I've decided to once again try my hand in some REITs - we have had a 5 basket short portfolio. Two of those names are now at resistance (SL Green (SLG) and ProLogis (PLD)) while the other 3 we hold in very small stakes are still above a key area (so the moving average is acting as support). So I am going to begin building these 2 names, and then the general index (which is the ETF IYR) with a 3% stake specific to that.

Any reader who has been around for a while knows my case against commercial real estate - we've done literally hundred+ posts. An amazing story in the Wall Street Journal about Atlanta... pretty much explains the horror that is (still) coming across this nation in Commercial Real Estate. Again, I ask you to drive around your neighborhoods and start taking a look very closely - you should be seeing a lot of "for lease" on office buildings and retail strips... this doesn't solve itself in months as the bulls would have you believe. Remember, we already have 6x more retail space per capita than any country on Earth. And we're still building...

WSJ: In Atlanta, Irrational Building Experience

• A one-mile stretch of Atlanta's upscale Buckhead neighborhood shows why commercial real estate is emerging as an obstacle to pulling the U.S. economy out of recession. Separate developers in Buckhead are building four speculative office buildings at the same time with virtually no leasing activity. The 35 recent condominium projects will help give Atlanta a 40-year supply at the current sales pace.
• The glut threatens to worsen the clobbering that many U.S. banks already are getting from nonperforming loans made to owners and developers of office buildings, shopping centers, condos and other commercial real estate.
• At Bank of America Corp., first-quarter results announced Monday included a surge in the percentage of commercial real-estate loans that are nonperforming to 7.5% of the Charlotte, N.C., bank's total portfolio of such loans. In Buckhead, Bank of America financed two of the four speculative office buildings just steps away from each other, despite little evidence there was demand for more than one of them. (this is what your tax dollars are bailing out... great deals like this)
• It also provided a loan for the Streets of Buckhead luxury retail development, now struggling as some retail tenants flee and go bankrupt. There already are two other luxury malls there. (2 luxury malls are never enough - more, more, more)
• The slump in the commercial real-estate sector could be a drag on the economic recovery. While some of the Atlanta projects already are defaulting on loans, others won't start running into financial problems for months or years, with a crescendo of loan maturities starting in 2010.
• "This is about as bad as it's been in modern times, and we haven't even seen most of the commercial damage yet," said Tom Bell, chief executive of Cousins Properties Inc., the Atlanta developer of one of the four towers. (thankfully his trade group is successfully lobbying the Federal Reserve to put your tax dollars at risk for his decisions. I'm sure it will work out in the end Mr. Bell - for you anyhow) He, like his three competitors, is bullish about his own project over the long term. (and why not? the tax payer is here to help him) [Apr 17: Surprise Surprise - Federal Reserve Succumbing to Commercial Real Estate Lobbying]
• ... (for the next tower) Bank of America provided the $116 million construction loan.
• ... (for the next tower) Bank of America again provided the financing: $108 million for the office portion of the mixed-use project, which also includes condominiums. (again, this is where your tax dollars are going - thanks BAC)

So we have 4 (count em!) spectacular buildings created in the craze. Tons of new square footage added to Atlanta in one neighborhood. What do we have to show for all 4?

• The Cousins building is the only one of the four to find a tenant: a 50,000-square-foot lease with Firethorn Holdings LLC, a mobile-banking company.

So let's review - 4 buildings, 3 completely empty. 1 has... 1 tenant. However, green shoots have been sighted on the premises therefore you know what to do ---> Buy commercial real estate stocks!

• Prospects that the Buckhead buildings will fill quickly are dim. Buckhead relies on financial-services companies as its best tenants. Those jobs are disappearing. What tenants they do attract are likely to poach from existing landlords, hurting the overall market.

While I'm still very net positive on the market in terms of positioning I am uneasy having such little short exposure. If we break north of S&P 875 I'll change my tune but until then I want to have more than 8%ish short exposure. I'm thinking we are in a quite large range between upper S&P 700s and lower S&P 900s for quite a few weeks to come as we battle between strands of economic data that say "good times" versus "not so good times" - but the whipsaws day to day continue to be relentless.

It would be nice to start putting in a series of days of +/- 0.5% on the indexes so individual stocks stop moving all in concert. For now still positive in a general fashion north of S&P 840, but I am seeing a lot of tired charts where we no longer are reaching highs reached in the past two weeks... this has to be corrected soon by breaking over those levels, or there is a risk of correction.

Wednesday's hot sectors were retail and restaurants as (yawn) the consumer is back. With Capital One Financials (COF) earnings out of the way (another huge short squeeze), I've added back some short exposure there along with Macy's (M) and Bed Bath & Beyond (BBBY).

p.s. is it me or is there a strange dichotomy watching gun stocks break out while we talk of green shoots and recovery? Hmmm...

Short IYR, SLG, PLD, COF, M, BBBY in fund; no personal position as of yet

Comments

[Respirate:]

Thanks for the Commercial Real Estate update. In more normal times I maintain about 15-20% of my portfolio in a Northeast US CRE holdings fund. It usually does very well with a minimum of drama and adds a dose of diversity. Looks like we're many months away from returning to that sector.

Apr 23 07:55 AM

[jimmy46:]

So you have 6 shorts in this sector,
I see that the REITs are selling at 66% of replacement cost and think they are a bargain.

You started touting shorting this sector a few months ago,
I'd guess that hasn't worked out for you.
We each place our bet and see who wins.

Apr 23 11:57 AM

[specsit:]

Atlanta real estate is not NY real estate.

Be cautious on mixing the two.

JMO

specsit

I am long SLG.

Apr 23 02:12 PM

[jhartz:]

That is true, the two have little in common........Other than the fact that in both areas vacancies are climbing and lease rates are falling.


On Apr 23 02:12 PM specsit wrote:

> Atlanta real estate is not NY real estate.
>
> Be cautious on mixing the two.
>
> JMO
>
> specsit
>
> I am long SLG.

Apr 23 03:16 PM

[levin70:]

Good article. I however would be leery shorting given how you so aptly describe that it now appears that pile on has already occurred on the short side of the trade.

Regards

Apr 23 04:15 PM

[Richard Woon:]

The REITs are headed to ZERO

Apr 23 05:02 PM

[TraderMark:]

Jimmy - been shorting sector since fall 2007

Only able to short individual names since 2009.



On Apr 23 11:57 AM jimmy46 wrote:

>
> You started touting shorting this sector a few months ago,
> I'd guess that hasn't worked out for you.
> We each place our bet and see who wins.

Apr 23 06:18 PM

[TraderMark:]

The pile on trade of buying highest leveraged is now everywhere - agree. If we are going to push these stocks up another 30% on "worst is now best" then you have to cut back and wait for the next opportunity

Market can move on momentum for long periods of time.



On Apr 23 04:15 PM levin70 wrote:

> Good article. I however would be leery shorting given how you so
> aptly describe that it now appears that pile on has already occurred
> on the short side of the trade.
>
> Regards

Apr 23 06:19 PM

[TraderMark:]

I'm more bearish on NYC than Atlanta frankly.

NYC has held up better than most and CRE is lagging. A year from now NYC office space will be in tatters.



On Apr 23 02:12 PM specsit wrote:

> Atlanta real estate is not NY real estate.
>
> Be cautious on mixing the two.
>
> JMO
>
> specsit
>
> I am long SLG.

Apr 23 06:20 PM

[Alan Young:]

The thesis makes sense, but...
I try shorting IYR almost every day. Almost every day I get stopped out. That gets costly after awhile.

Either (1) insiders know of something coming down the pipe that's going to rescue the whole sector, or (2) "da boyz" are trying to coax more retail $$ into the stocks before slamming them into oblivion, or (3) the market is even more incredibly irrational than usual.
I lean toward #2, which is why I continue my contrarian bets.
Thanks for the updates, Mark.

Apr 23 06:55 PM

[Steak:]

I live on said strip in a condo built around 2003 (still less than 75% occupancy) with a picturesque view of the Terminus buildings mentioned in the article. In a blissful bit of cosmic comeuppance the first of the Terminus buildings was completed in 2007 and all the most prominent financial firms in Atlanta (both of em) promptly re-located there. This year the rent in the just completed neighboring building will be almost half what they paid.

The luxury retail development has been laughable from the get go. This area had the best nightlife in the city which got on the nerves of lord knows who, so the city decided they were going to make the streets family friendly by putting in a Prada and Gucci (or similarly calibured stores). And the two other luxury malls happen to be less than a mile away up Peachtree and are across the street from eachother. Whoever is building that thing bought up a whole swath of land on Peachtree right at the top and now has a shiny hole in the ground to show for it. In a classic bit of "if we build it" a central premise was to make the area more walkable. This is the most walkable square mile of Atlanta already and I count a total of ONE person walking to work every day (a cute blonde, I judge how late I am by when I pass her).

Mind you all these things are being built around the intersection of the two most prominent streets in Atlanta, Peachtree and Piedemont. Going a mile (two, three, ten, what have you) in any direction it is apparent that at the BARE minimum one in ten storefronts are up for lease. The success of the whole Buckhead area is wholly dependant on cannibalizing tennants from the burbs, which is happening but has a squeezing a balloon on one side feel to it.

Either way, peace up, A-town down

Apr 23 09:25 PM

[{5U}:]

Where would you get the financing to buy the Replacement Cost?

Ever look at the CMBS market?

Or would you buy it in cash.

On Apr 23 11:57 AM jimmy46 wrote:

> So you have 6 shorts in this sector,
> I see that the REITs are selling at 66% of replacement cost and think
> they are a bargain.
>
> You started touting shorting this sector a few months ago,
> I'd guess that hasn't worked out for you.
> We each place our bet and see who wins.

Apr 24 12:01 AM

[Dr. O:]

This will not end well. Sounds like we are in the early innings of a prolonged real estate downturn that may take the better part of a decade to work through. Many bankruptcies surely to come.

In the meantime, stocks jump around based on various forms of manipulation: buy calls or sell puts, then jam the stock up. sell the calls or buy back the puts, then dump the stock, etc.

Apr 24 04:44 AM

[felixd:]

Interesting thesis and you may well be justified. However, there are huge regional differences to real estate market, both commercial and residential. Lots of ink already on the southwest and florida markets and how long it willtake for them to recover. Funny you dont see much talk about Washington DC real estate issues. With the losest unembloyment rate in the nation and Obama promise to hire more fed workers, it would appear that the DC market is going to boom. take a look at WRE. Would you reall want to short that?

Apr 24 08:30 AM

[takesolace:]

thank you, this is very interesting color on one specific area- though i'm sure similar stories abound across the country. that said, why fight the current trend? as of 4/24, here's what your names have returned since YE07: IYR (-49%), PLD (-87%), SLG (-79%).

if you've been short these names, then you already won. if your thesis is correct, why not wait for the market to stop rallying before shorting this sector? the only plausible argument i can make for shorting these names right now is imminent bankruptcy i.e. who is the next GGP? also, consider the possibility that lenders may be more willing to refinance CRE debt in the coming years with government support.

Apr 24 10:22 PM

[ocean 2026:]

SLG is selling at 1/3 of book value but its mostly New York. Do you actually know its properties and their real current value or are you blindly shorting because you don't care for commercial real estate.

CLP and BDN both have good locations - are you shorting them too?

Apr 26 11:41 PM

[ocean 2026:]

SLG is selling at 1/3 of book value but its mostly New York. Do you actually know its properties and their real current value or are you blindly shorting because you don't care for commercial real estate.

CLP and BDN both have good locations - are you shorting them too?

Apr 26 11:41 PM

[On Going Co...:]

good article. ProLogis has a large portfolio in Dallas that they have been actively marketing to sell through CBRE and has had very little takers in the past 8 months.

Also the condo market in Dallas has about 8 years of oversupply. All these high-rise condo projects are beginning to switch to leasing mode.

May 21 01:01 PM